Taxes in retirement can be a major pain point. Just when you thought you’d found the fountain of youth, it turns out there’s no such thing as a free lunch. If you have any doubt about this, just start reading the fine print on your pension statements and bank account statements. Taxes are everywhere!

Does your holistic retirement plan account for taxes in retirement?

Taxes are a big part of retirement planning. Unfortunately, many people don’t realize how much taxes can impact their financial situation in retirement. It’s important to consider all aspects of your income, expenses and savings, and how they work together when planning for the future so that you don’t miss out on tax breaks that could help significantly reduce your tax bill.

The first thing that you need to understand is that, as a retiree, your income will be significantly different than it was during your working years. You may have access to some of your savings accounts during retirement, but it’s likely that you’ll have less money coming in each month and more expenses.

Here are 4 taxes you may want to reduce – or eliminate – in retirement: 

1. Income Tax

The first of these taxes is the income tax. The federal income tax is based on how much money you make and how old you are. In general, retirees pay less in taxes than working folks because their income level has dropped significantly.

However, if your retirement savings are large enough to land you among the highest earners—and/or if you make a lot of money from capital gains (the profit from selling an investment)—you may still be subject to higher rates than your peers who continue working full-time jobs during their golden years. 

It’s also important to understand how your income taxes will be affected in the event of your spouse passing away. If you and your spouse filed your income tax return as “Married, filing jointly”, the surviving spouse will now have to file his/her income taxes as “Single” moving forward. This shift alone may push the individual into a higher tax bracket and he/she will no longer receive the lower “Married, filing jointly” tax rate they previously received. 

2. Required Minimum Distributions (RMDs) Tax

Required Minimum Distributions (RMDs) are required by the IRS. If you’re saving for retirement in a traditional IRA or employer-sponsored retirement plan, you must take your first RMD by April 1st of the year after you turn age 72. After that, RMDs must be taken annually. If the majority of your assets are in qualified retirement accounts – such as 401ks, IRAs etc. –  you could be pushed into a higher tax bracket forcing you to pay more in taxes. This is especially true if you believe tax rates will go up in the future.

3. Social Security Benefit Tax

Your Social Security benefit is subject to taxes in retirement and RMDs can trigger your benefit to be taxed up to 85%! Social Security retirement benefits are taxed based on your provisional income (Provisional Income = Adjusted Gross Income + Non-taxable interest + 1 ½ of Social Security benefits). Depending on what your provisional income is, either 0%, up to 50%, or up to 85% of your benefits received could be subject to federal income tax. 

Again, if the bulk of your retirement income is coming from qualified accounts (like 401ks and IRAs), you most likely will have a higher provisional income than if your assets were coming from non-qualified accounts (like Roth IRAs and Life Insurance).

It’s important to have financial strategies in place that help reduce your provisional income, thus reducing the amount of taxes you pay on your Social Security benefits so you can keep more of your hard-earned savings. 

4. Capital Gains Tax

Capital gains tax is the tax you pay when you sell an asset that has increased in value. For example, if you bought a stock for $1,000 and sold it for $2,000, then there would be a capital gain of $1,000. Capital gains taxes are usually lower than income taxes because they’re only paid on profits above your investment’s cost basis—the original price you paid for the stock or whatever asset was sold—and capital gains are taxed at a lower rate than other types of income.

Also note that if an asset has been held for less than one year before selling it (you think we’re talking about stocks here? Nope; rental properties count too), any profit made from that sale is considered short-term capital gains and taxed as normal income. However, if your rental property was held longer than 12 months before being sold (again: same rules apply to all types of assets), then any profit made from that sale will likely qualify as long-term capital gains and therefore be taxed at 15% (for those who make less than $38k) or 20% (for everyone else).

Planning for retirement requires planning for taxes.

Taxes are a part of life, even when you’re retired. As you can see, taxes in retirement are more complicated than during your working years. You need to plan for income tax, RMDs, Social Security tax, and capital gains tax—and that’s just on the federal level! If you live in a state that has an income tax, there are additional considerations.

Planning for taxes in retirement is a complicated task, but it can be done. The first step is to talk with your financial professional and create a plan that works for you. Once you have a plan, be sure to update it every year. The tax code is always changing, and your situation can change as well.

If you’d like to learn more about other strategies for saving taxes in retirement and reducing your overall tax bill, schedule your complimentary Financial Analysis here.